What does the smart money in the market say about the fourth quarter hog outlook?
“At-the-money options are more than double what they would typically be at this time,” Tyler Fulton, Hams Marketing’s director of risk management, said in an interview.
“What we’re seeing is the uncertainty manifest itself in the market.”
While futures prices essentially reveal the price buyers and sellers arrive at as the most reasonable estimate of an average forward price, options premiums reveal the underlying volatility expected in the market.
When options writers doubt there will be much rise or decline in futures prices from today’s values, premiums tend to be small. When options writers see a significant chance of prices moving in a dramatic fashion, they demand higher premiums.
That’s the situation for the ever-scary fourth quarter of the year, in which price slumps tend to occur.
There are both bullish and bearish wild cards being played out in front of the markets in the next weeks, and those could send prices surging or slumping.
- U.S. hog supplies: The American hog herd has surged ahead this year, well beyond most expectations, after years of only marginal year-over-year increases.
“U.S. hog production is running very high,” said Ken Ball of P.I. Financial.
That means there will be a lot of pork to move in coming months and getting rid of it might not come without price discounting.
Packer margins are good, so they will keep buying, but there’s just a lot to move. That won’t help keep hog prices from weakening.
“We keep creeping higher in terms of hog numbers,” said Fulton.
“It’s just a shocker.”
- China: Taming the price-reducing pressure of higher hog numbers has been widespread expectations that China, beset by enormous African swine fever losses, will begin importing huge amounts of pork.
That drove Chicago lean hogs futures high until July, with the December contract hitting $80 per hundredweight, but as time has gone on and China has not bought anywhere near what traders and producers expected, prices have settled back, falling to about $60 recently.
If China does suddenly appear on the market and buys a lot of U.S. pork, prices could surge.
But without that huge buyer to sop up the big supplies, prices could drop further as other markets are chased.
Currently, hog futures aren’t much different than at this time every year for about five years.
“The hog market is very rapidly falling back into its typical patterns,” said Ball.
“It certainly looks like we’re heading towards a typical low.”
That low price is probably somewhere from the high $40s to low $50s, so just a few dollars beneath today’s US$56 cash market value.
But that expectation could be shattered by any major Chinese buying, or outbreaks of swine disease in North America or elsewhere.
Recently, the Philippines and Thailand have discovered ASF ravaging their herds, so the disease is a real factor in the world’s supply-and-demand outlook.
Where it will break next is anybody’s guess.
- Trade wars: On top of the U.S. supply and Chinese disease factors is the extreme unpredictability of the trade wars now raging between the U.S. and China, and China’s trade action against Canada.
How those evolve will affect pork sales, pork flow and pork prices, but guessing the outcome is “a fool’s game,” said Fulton.
As it looks now, hog prices for the fourth quarter aren’t unusual and spring and summer 2020 prices are strong.
But options premiums reveal that the unpredictability of where prices actually end up is far higher than in most recent years.
“We’re just in a new time, I guess,” said Fulton.